Understanding Tokenized US Treasury Bills

What are US Treasury bills?

US Treasury Bills, also known as T-Bills, are short-term debt securities issued by the US Treasury Department. T-bills are a real world asset considered among the safest investments possible, due to being backed by the full faith and credit of the United States Government.

How do Treasury Bills work?

T-bills are short-term financial instruments issued by the US Treasury with maturity periods ranging from a few days to one year.

The most common maturities are 4, 8, 13, 26, and 52 weeks. On average, the longer the maturity date, the higher the interest rate that the T-Bill will pay to the investor.

Unlike many other types of securities, US Treasury Bills do not pay regular dividends. Instead, T-bills are sold at a discount from their face value. When the T-bill matures, the investor receives the full face value.

Understanding T-Bill yield

The difference between the purchase price and the face value of a US Treasury Bill represents the interest earned. The important figures to understand are the Purchase Price, Annualized Discount Yield, and Yield to Maturity.

Purchase Price

The purchase price can be determined from the following formula, where “F” is face value (normally $1000), “P” is the purchase price, “t” is the time to maturity (in days), and “R” is the annualized discount yield:

P = F/(1-tR/360)

Example 1: A $1,000 28-day bill sells at auction for an annualized discount yield of 4.2%.

Price = 1000 (1 – (.042 x 28)/360) = $996.73 The formula shows that the bill sells for $996.73, giving you a discount of $3.27. When you get $1,000 after 28 days, you have earned $3.27 in “interest”.

Annualized Discount Yield

Annualized Discount Yield is the yield quoted on US T-bills. It is calculated on a simple interest basis (ie., without compounding) on a 360 day-year basis, expressed as a percentage of the instrument’s face value. To calculate the discount yield for T-bills, the following formula is used:
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Annualized Discount Yield = [(F – P)/F] x (360/t)

‍Example 2: You pay $996.73 for a 28 day T-bill. It is worth $1,000 at maturity. The Annualized Discount Yield is: (1000-966.73)/1000*360/28 = 4.2% 

Yield to Maturity

The most important figure – the one useful to understand the return investors will generate from a Treasury Bill – is the Yield to Maturity (YTM). YTM is the bill’s annualized return yield, based on a 365 or 366 day year. The YTM assumes that the buyer of the bills will hold them until the maturity date.
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YTM = (F-P)/P*365/t

Example 3: Continuing from Example 2, the YTM is: (1000-966.73)/966.73 * 365/28 = 4.28% 

What influences T-Bill prices?

Many factors can influence T-Bill prices, including monetary policy, interest rate changes, maturity period, market risk tolerance and inflation. 

Interest Rates

There is an inverse relationship between interest rates and T-bill values. As market interest rates rise, T-bill prices typically fall in a short run, and vice versa. This is because new T-bill issuances will be sold at a deeper discount (higher interest rate) after a rate hike, dropping the value of outstanding T-bills as a result. 

It is critical to understand that investors will still receive the full face value of the T-bills at the maturity day, despite any fluctuations in the purchase price. The price drop following an interest rate increase is a short-term change, with no impact on investors who hold T-bills to maturity.

Investors will always receive the full face value of a T-bill when it reaches maturity. T-bill purchase price fluctuations only impact those looking to sell before maturity.

Finally, it is worth noting that interest rates fluctuate on a daily basis, not strictly as a result of Central Bank intervention. 

Maturity

T-bills with longer maturity dates tend to have higher returns than those with shorter maturities. In other words, short-term T-bills are discounted less than longer-dated T-bills.

This is generally because with longer-dated maturities there is greater chance that interest rates could rise, so there’s more risk priced in.

What are “on-the-run” treasury bills?

On-the-run T-bills are the most recently issued treasury bills of a particular maturity.  Whenever a new set of T-bills is created and sold by the government, they become the current “on-the-run” issuance.

Example 4: A new set of 52-week bills are created and sold today (Set A). These are now the current on-the-run bills. If a new set (Set B) gets issued next month, Set A would then be considered off-the run, and Set B becomes on-the-run.

Because there are fewer on-the-run T-bills, they are the most actively traded and the most highly liquid treasury bonds. This generally means that they are slightly higher priced and lower yield than off-the-run bills.

Typically, when the price or yields of Treasury bills are mentioned in media, those refer to the on-the-run issuance.

What is a Roll-Down Return?

As shown above, the interest rate on longer-term bonds will generally be higher than the yield earned from short-term bonds. 

In general, as its maturity date grows closer, a bond's interest rate moves closer to zero.

This allows for a bond-trading strategy called rolling down, which is executed by and continually purchasing on-the-run T-bills and selling well before they reach their maturity date. 

Since the purchase price of a T-bill generally raises over time, investors can earn money by “rolling down” the yield curve.

Example 4: A $1,000 28-day bill sells at auction for an annualized discount yield of 4.2%, while a 7-day bill sells for an annualized discount yield of 3.6%. After three weeks, the 28-day bill becomes a 7-day bill. Because the difference in yield between the 28 day and the 7 day is 0.8%, the 7-day bill can rise 0.8% before exceeding the YTM of 4.2%.

Tokenizing US Treasury Bills

In Web3 terms, tokenization refers to the concept of converting real world assets like treasury bills into a digital token that can be held, traded and transferred on a blockchain. 

Generally, companies offering tokenization of a physical asset will purchase and hold reserves of that asset, while issuing a token backed by their reserves.

How are US Treasury Bills tokenized?

As with any tokenized real world asset, US Treasury bills can be tokenized by being purchased by an entity and held in reserve in a “pool”. The entity then issues tokens that represent a stake in the pool.

These tokens are a form of cryptocurrency, and benefit from the typical benefits characteristic of crypto – including immutability, transaction speed, and transparency.

What are the benefits of tokenizing US T-bills?

By tokenizing US T-bills, many new benefits are added to the already popular instruments. These benefits are made possible by the blockchain technology that powers the tokens that represent a stake in the overall pool. Those benefits include:

Wider Access to US Treasury Yield

Tokenizing T-bills allows them to be much more easily bought, sold, held and traded by individuals outside of the US.

Typically, an investor in Latin America or Africa looking to invest in US T-bills would have to undergo a lengthy process of converting their local currency into USD, finding an online brokerage willing and licensed to sell securities out of country, wire the USD (with hefty fees), and manually manage any trading strategy such as buying the on-the-run issuances.

Tokenization allows fintechs to instead offer the tokens to their local users in exchange for USDC, without cross-border payment rails or fees. This means many, many more people globally can benefit from one of the safest investments available.

Automatic Roll-Down Strategies

Typically, a provider of tokenized US T-bills will be managing the trading strategy of their treasury bond reserve. Traditionally, this refers to maximizing the yield by “rolling down” the yield curve, as explained above.

Investors unwilling or unable to manually manage their trading strategy can instead purchase tokenized bonds to be assured that the yield they are receiving has been automatically optimized.

New Types of Collateral

Traditionally, US T-bills represent a safe investment in which to hold savings and earn yield. If those savings are to be utilized as collateral, the T-bills must be liquidated for cash.

Tokenization of real world assets such as T-bills presents new opportunities for collateral. This includes the possibility of using the cryptocurrency tokens that represent a stake in the T-bill pool as collateral directly.

This allows an entity requiring collateral to receive a highly liquid, cash-redeemable token that continues to earn yield for its owner, unlike cash.

How to offer tokenized US Treasury Bill Yield

Companies looking to offer their users tokenized US Treasury bills (without directly purchasing the securities, issuing a cryptocurrency, proving reserves and managing yield strategies) can embed their product with the infrastructure required to connect to tokenized T-bill yield pools.

What is required to offer tokenized US T-bill yield?

Crypto Wallets

Crypto wallets are need to initiate transfers in and out of tokenized t-bill yield pools. For more information on how crypto wallets work, see our guide.

On & Off Ramps

A solution for exchanging local fiat currencies into stablecoins such as USDC – which are deposited into tokenized t-bill yield pools in exchange for the pool tokens – is required. As well, users need a way to redeem their stablecoins back into local fiat smoothly.

Transaction Ledger

In addition to wallets, a system for recording and displaying transactions – including deposits, withdrawals and accrued yield – is necessary to display to users.

Conduit can help

Conduit's end-to-end platform allows fintechs to invisibly connect to US Treasury bill token pools in an easy, safe and regulation-friendly way. With a single API, fintechs can offer their users access to a safe, highly liquid investment from outside of the US.

For a demo of our platform, contact us today.

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